What Is Invested Capital?

Invested capital is when a company gets money by selling stocks to owners and bonds to bondholders. The total debt and capital lease obligations are added to the amount of stock sold to investors to get the invested capital. The company’s financial statement has no line item for invested capital because loans, capital leases, and stockholders’ equity are all shown separately on the balance sheet.

How to Understand Invested Capital

Businesses must make more money from sales than it costs to get money from bondholders, shareholders, and other sources of financing. If they don’t, the business doesn’t make an economic return. Return on invested capital, economic value added, and return on capital worked are ways businesses measure how well a company uses its capital.

The total capitalization of a company is the sum of the debt it has given, which includes capital leases and the equity it has sold to investors. The balance sheet shows both types of capital in different places. For example, let’s say IBM sells 1,000 shares of stock with a face value of $10 each. Each share is sold for $30. IBM adds the entire $10,000 in par value to the standard stock balance in the stockholders’ equity part of the balance sheet. The other $20,000 goes to the additional paid-in capital account. If, on the other hand, IBM issues $50,000 in company bonds, that amount will be added to the long-term debt in the balance sheet. Because it issued new shares and debt, IBM’s capitalization went up by $80,000.

How issuers get their money back

A good business gets the best rate of return on the money it borrows, and investors pay close attention to how companies spend the money they get from selling stock and debt. Let’s say a plumbing company sells $60,000 worth of extra stock and uses the money from the sales to buy more plumbing trucks and tools. As long as the plumbing company can use its new tools to do more work on homes, it will make more money and be able to give its owners a dividend. Each investor’s rate of return on a stock investment goes up because of the income. Investors also make money when the price of a stock goes up because the company is making more money and selling more products.

Companies can also use some of their earnings to buy back stock given to investors and retire it. This drops the number of shares that are outstanding and the equity balance. The net income made per share of stock is also something that analysts pay close attention to. This is called earnings per share (EPS). When a company buys back its shares, the number of shares that are still out there goes down. This means the EPS goes up, making the stock more appealing to investors.

How Much Money You Made Back (ROIC)

Return on invested capital, or ROIC, is a way to figure out how well a business is using the money it has to make purchases that will make it money.

The return ratio on spent capital shows how well a business uses its money to make money. You can tell if a company uses its invested capital well by comparing its return on invested capital to its weighted average cost of capital (WACC). This number is also sometimes just called “return on capital.”

When figuring out ROIC, you always use a percentage and give the number as an annualized or trailing 12-month value. It should be compared to a business’s cash cost to see if it is making money. The most popular way to measure the cost of capital is the weighted average cost of capital (WACC). If ROIC is higher than WACC, value is created, and these companies will trade at a higher price. A return of more than 2% of the company’s cost of capital is often used as proof that value has been created. It is a value killer for a company if its ROIC is less than 2%. Some businesses run at a level of zero return. They may not be destroying value, but they also don’t have any extra cash to spend on growth.

ROIC is one of the most important and valuable ways to determine a company’s value. Still, it’s more important for some industries than others. For example, companies that run oil rigs or make semiconductors spend much more money on tools than those that make other things.

Conclusion

• It includes capital leases. Invested capital is the sum of all the equity and debt capital that a company has raised.
• Return on invested capital, or ROIC, shows how well a company makes money with the money it has spent.
• The weighted average cost of capital of a company tells how much it costs to keep spent capital in the company.